The following discussion summarizes the significant factors affecting the
consolidated operating results, financial condition, liquidity, and cash flows
of our Company as of and for the periods presented below and should be read in
conjunction with the financial statements and accompanying notes included with
this Quarterly Report on Form 10-Q. This discussion contains forward-looking
statements that are based on the beliefs of our management, as well as
assumptions made by, and information currently available to, our management.
Actual results could differ materially from those discussed in or implied by
forward-looking statements as a result of various factors. See "Forward-Looking
We were founded in
Convertible Notes Issuance
Section 312 of the NYSE Listed Company Manual requires, among other things, that we obtain shareholder approval in order for the number of shares of our common stock to be issued upon conversion of the Notes to equal or exceed 20% of the shares of our common stock outstanding before we issued the Notes (the "NYSE Limit"). Accordingly, we are seeking shareholder approval at our upcoming annual meeting on
Until we obtain shareholder approval we will settle any conversion of the Notes through the combination settlement described above. As a result, we have bifurcated a conversion derivative that is embedded in the Notes and recorded it separately at fair value as a liability with changes in its fair value recorded in earnings. We recorded the difference between the principal amount of the Notes and the conversion derivative liability as a debt discount which is subsequently amortized to interest expense over the expected life of the Notes using the effective interest method. If we obtain shareholder approval in the second quarter of 2014 to exceed the NYSE Limit, we would expect to reclassify the conversion derivative liability to equity along with any unamortized transaction costs proportionate to the allocation of the initial debt discount and the principal amount of the Notes. In subsequent reporting periods, if the reclassification occurs, the Notes will be recorded at accreted value up to the par value of the Notes at maturity. The debt discount will be amortized into interest expense using the interest method, in an aggregate amount equal to the amount of the conversion derivative liability reclassified into equity along with any unamortized transaction costs.
During the three months ended
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While the liquidity risk associated with the policies that have been pledged as collateral under the Revolving Credit Facility has been significantly mitigated, any available proceeds under the facility's waterfall provisions will generally be directed to pay outstanding interest and principal on the loan, unless the lenders determine otherwise. Accordingly, there can be no assurance as to when the proceeds from maturities of the policies pledged as collateral under the Revolving Credit Facility will be distributed to the Company. The Company believes it may be at least five years before the Company receives meaningful distributions from these policies. As such, the Company must proactively manage its cash in order to effectively run its businesses, maintain the policies that have not been pledged under the Revolving Credit Facility and opportunistically grow its assets. The Company may in the future pledge and/or borrow against certain or all of the 149 policies that have not been pledged under the Revolving Credit Facility. It may also determine to sell all or a portion of these policies and, under certain circumstances, lapse certain of these policies as its portfolio strategy and liquidity needs dictate. Should it choose to maintain all of the policies that have not been pledged as collateral under the Revolving Credit Facility, the Company estimates that it will need to pay approximately
During the quarter ended
Critical Accounting Policies Critical Accounting Estimates
The preparation of the financial statements requires us to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. We base our judgments, estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions and conditions. We evaluate our judgments, estimates and assumptions on a regular basis and make changes accordingly. We believe that the judgments, estimates and assumptions involved in the accounting for income taxes, the valuation of investments in life settlements, the valuation of the debt owing under the Revolving Credit Facility and the valuation of our conversion derivative liability embedded within the Notes have the greatest potential impact on our financial statements and accordingly believe these to be our critical accounting estimates. Below we discuss the critical accounting policies associated with the estimates as well as selected other critical accounting policies.
Fair Value Option
We have elected to account for the debt under the Revolving Credit Facility, which includes its interest in policy proceeds to the lender, using the fair value method. The fair value of the debt is the amount the Company would have to pay to transfer the debt to a market participant in an orderly transaction. We calculated the fair value of the debt using a discounted cash flow model taking into account the stated interest rate of the credit facility and probabilistic cash flows from the pledged policies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, our estimates are not necessarily indicative of the amounts that we, or holders of the instruments, could realize in a current market exchange. The most significant assumptions are the estimates of life expectancy of the insured and the discount rate. The use of different assumptions and/or estimation methodologies could have a material effect on the estimated fair values.
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The Company determined that the embedded conversion option in the Notes is required to be separately accounted for as a derivative under Accounting Standards Codification ("ASC") 815, Derivatives and Hedging. ASC 815 requires the Company to bifurcate the embedded conversion option and record it as a liability at fair value and reduce the debt liability by a corresponding discount of an equivalent amount. The embedded conversion option is required to be re-measured at fair value at each reporting date with gains or losses recognized in earnings The Company uses a Black Scholes pricing model that incorporates present valuation techniques and reflects both the time value and the intrinsic value of the embedded conversion option to approximate the fair value of the conversion derivative liability at the end of each reporting period. This model requires assumptions as to expected volatility, dividends, terms, and risk free rates.
Fair Value Measurement Guidance
We follow ASC 820, Fair Value Measurements and Disclosures, which defines fair value as an exit price representing the amount that would be received if an asset were sold or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions the guidance establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. Level 1 relates to quoted prices in active markets for identical assets or liabilities. Level 2 relates to observable inputs other than quoted prices included in Level 1. Level 3 relates to unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Our investments in life insurance policies, structured settlements, Revolving Credit Facility debt and conversion derivative liability are considered Level 3 as there is currently no active market where we are able to observe quoted prices for identical assets/liabilities and our valuation model incorporates significant inputs that are not observable. See Note 11, Fair Value Measurements of the notes to Consolidated Financial Statements for a discussion of our fair value measurement.
Income Recognition from Continuing Operations
Our primary source of income from continuing operations are in the form of change in fair value of life settlements and gains on life settlements, net. Our income recognition policies for this source of income is as follows:
• Change in Fair Value of Life Settlements-When the Company acquires certain life insurance policies we initially record these investments at the transaction price, which is the fair value of the policy for those acquired upon relinquishment or the amount paid for policies acquired for cash. The fair value of the investment in insurance policies is evaluated at the end of each reporting period. Changes in the fair value of the investment based on evaluations are recorded as changes in fair value of life settlements in our consolidated statement of operations. The fair value is determined on a discounted cash flow basis that incorporates current life expectancy assumptions. The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life insurance policy and our estimate of the risk premium an investor in the policy would require. The Company recognizes income from life settlement maturities upon receipt of death notice or verified obituary of insured. This income is the difference between the death benefits and fair values of the policy at the time of maturity. • Gains on Life Settlements,
Net-The Companyrecognizes gains from life settlement contracts that the Company owns upon the signed sale agreement and/or filing of ownership forms and funds transferred to escrow.
Income Recognition from Discontinued Operations
Our primary source of income from discontinued operations are in the form realized gains on sales of structured settlements.
Realized Gains on Sales of Structured Settlements-Realized gains on sales of structured settlements are recorded when the structured settlements have been transferred to a third party and we no longer have continuing involvement, in accordance with ASC 860, Transfers and Servicing.
Deferred costs include costs incurred in connection with acquiring and maintaining credit facilities. These costs are amortized over the life of the related loan using the effective interest method and are classified as interest expense in the accompanying consolidated statement of operations. These deferred costs are related to the Company's 8.50% senior unsecured convertible notes. The Company did not recognize any deferred cost on its Revolving Credit Facility given all costs were expensed due to electing the fair value option in valuing the Revolving Credit Facility.
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Prior to our initial public offering in 2011, we converted from a
We account for income taxes in accordance with ASC 740, Income Taxes. Under ASC 740, deferred income taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of enacted tax laws. Deferred income tax provisions and benefits are based on changes to the assets or liabilities from year to year. In providing for deferred taxes, we consider tax regulations of the jurisdictions in which we operate, estimates of future taxable income and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies varies adjustments to the carrying value of the deferred tax assets and liabilities may be required. Valuation allowances are based on the "more likely than not" criteria of ASC 740.
Our provision for income taxes is estimated to result in an annual effective tax rate of 38.8% in 2014, except as noted below. For periods prior to 2014 our provision for income taxes is estimated to result in an annual effective tax rate of 0.0%. At
The accounting for uncertain tax positions guidance under ASC 740 requires that we recognize the financial statement benefit of a tax position only after determining that the relevant tax authority would more likely than not sustain the position following an audit. For tax positions meeting the more-likely-than-not threshold, the amount recognized in the financial statements is the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement with the relevant tax authority. We recognize interest and penalties (if any) on uncertain tax positions as a component of income tax expense.
In March of 2014, the Company was notified by the
We have adopted ASC 718, Compensation-Stock Compensation. ASC 718 addresses accounting for share-based awards, including stock options and warrants, with compensation expense measured using fair value and recorded over the requisite service or performance period of the award. The fair value of equity instruments awarded upon or after the closing of our initial public offering will be determined based on a valuation using an option pricing model that takes into account various assumptions that are subjective. Key assumptions used in the valuation will include the expected term of the equity award taking into account both the contractual term of the award, the effects of expected exercise and post-vesting termination behavior, expected volatility, expected dividends and the risk-free interest rate for the expected term of the award.
Held-for-sale and discontinued operations
The Company reports a business as held-for-sale when management has approved or received approval to sell the business and is committed to a formal plan, the business is available for immediate sale, the business is being actively marketed, the sale is anticipated to occur during the ensuing year and certain other specified criteria are met. A business classified as held-for-sale is recorded at the lower of its carrying amount or estimated fair value less cost to sell. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. Depreciation is not recorded on assets of a business classified as held-for-sale. Assets and liabilities related to a business classified as held-for-sale are segregated in the Consolidated Balance Sheet and major classes are separately disclosed in the notes to the Consolidated Financial Statements commencing in the period in which the business is classified as held-for-sale. The Company reports the results of operations of a business as discontinued operations if the business is classified as held-for-sale, the operations and cash flows of the business have been or will be eliminated from the ongoing operations of the Company as a result of a disposal transaction and the Company will not have any significant continuing involvement in the operations of the business after the disposal transaction. The results of discontinued operations are reported in Discontinued Operations in the Consolidated Statement of Operations for current and prior periods commencing in the period in which the business meets the criteria of a discontinued operation, and include any gain or loss recognized on closing or adjustment of the carrying amount to fair value less cost to sell.
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Recent Accounting Pronouncements
Note 2, Principles of Consolidation and Basis of Presentation of the Notes to Consolidated Financial Statements discusses accounting standards adopted during the three months ended
Results of Operations
The following is our analysis of the results of operations for the periods indicated below. This analysis should be read in conjunction with our financial statements, including the related notes to the financial statements. Our results of operations are discussed below in two parts: (i) our consolidated results of continuing operations and (ii) our results of discontinued operations.
Results of Continuing Operations
Three Months Ended
Net loss from continuing operations for the quarter ended
Our net loss for the quarter ended
Change in Fair Value of Life Settlements. Change in fair value of life settlements was a gain of approximately
During the quarter ended
Of these 601 policies owned as of
Gain/(Loss) on life settlements, net. Loss on life settlements, net was approximately
Servicing Fee Income. Servicing income was zero for the quarter ended
Other Income. Other income was
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Interest expense. Interest expense increased to
Change in fair value of Revolving Credit Facility. Change in fair value of Revolving Credit Facility was approximately
Change in fair value of conversion derivative liability. Change in fair value of conversion derivative liability embedded in the Notes was approximately
Selling, General and Administrative Expenses. SG&A expenses were
Legal expenses for the quarter ended
Results of Discontinued Operations
Three Months Ended
Net loss from our discontinued structured settlement operations for the quarter ended
Total expenses from our discontinued structured settlement operations were
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Continuing Operations-Selected Operating Data (dollars in thousands):
Life Finance For the Three Months Ended March 31, 2014 2013 Period Acquisitions - Policies Owned Number of policies acquired - 8 Average age of insured at acquisition - 76.8 Average life expectancy - Calculated LE (Years) - 12.3 Average death benefit $ -
$ 4,094Aggregate purchase price $ - $ 1,524End of Period - Policies Owned Number of policies owned 601 220 Average Life Expectancy - Calculated LE (Years) 11.4 10.8 Aggregate Death Benefit $ 2,920,399 $ 1,099,906Aggregate fair value $ 315,464 $ 117,732Monthly premium - average per policy $ 7.5 $ 10.4End of Period Loan Portfolio Loans receivable, net $ - $ 1,769Number of policies underlying loans receivable - 14
Aggregate death benefit of policies underlying loans receivable
$ 56,900Number of loans with insurance protection - 5 Loans receivable, net (insured loans only) $ - $ 93Average Per Loan: Age of insured in loans receivable - 75.8 Life expectancy of insured (years) - 15.6 Monthly premium $ - $ 5 Loan receivable, net $ - $ 126Interest rate - 12.5 % 37
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Discontinued Operations-Selected Operating Data (dollars in thousands):
Structured Settlements: For the Three Months Ended March 31, 2014 2013 Period Originations: Number of transactions 3 171 Number of transactions from repeat customers 2 85 Average purchase discount rate 15.0 % 17.4 %
Face value of undiscounted future payments purchased
$ 117 $ 5,539Marketing costs $ - $ 811 Selling, general and administrative (excluding marketing costs) $ - $ 3,138
Average Per Origination During Period: Face value of undiscounted future payments purchased
$ 39$ 32 Time from funding to maturity (months) 242 155 Marketing cost per transaction $ - $ 5 Segment selling, general and administrative (excluding marketing costs) per transaction $ - $ 18 Period Sales: Number of transactions originated and sold 8 163
Realized gain on sale of structured settlements
10.5 % 9.8 % End of Period Portfolio: Number of transactions on balance sheet 50 97
Liquidity and Capital Resources
Our consolidated financial statements have been prepared assuming the realization of assets and the satisfaction of liabilities in the normal course, as well as continued compliance with the covenants contained in the Revolving Credit Facility and other financing arrangements.
We expect to meet our liquidity needs for the next year primarily through our cash resources. While the liquidity risk associated with the policies that have been pledged as collateral under the Revolving Credit Facility has been mitigated, any available proceeds under the facility's waterfall provisions will generally be directed to pay outstanding interest and principal on the loan unless the lenders determine otherwise. Accordingly, there can be no assurance as to when the proceeds from maturities of the policies pledged as collateral under the Revolving Credit Facility will be distributed to the Company. The Company must proactively manage its cash in order to effectively run its businesses, maintain the policies that have not been pledged under the Revolving Credit Facility and opportunistically grow its assets. The Company may in the future pledge and/or borrow against certain or all of the 149 policies that have not been pledged under the Revolving Credit Facility, the majority of which had historically been maintained by the lender protection insurance provider. It may also determine to sell all or a portion of these policies and, under certain circumstances, lapse certain of these policies as its portfolio management strategy and liquidity needs dictate. The lapsing of policies, if any, would create losses as such assets would be written down to zero.
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Financing Arrangements Summary
Revolving Credit Facility
There are no scheduled repayments of principal. Payments are due upon receipt of death benefits and distributed pursuant to the waterfall as described above.
8.50% Senior Unsecured Notes Due 2019